Small-Cap Funds Definition
A company’s market capitalization is the total value of all its outstanding shares. The smaller the company, the greater the potential for growth, as the market may undervalue it.
Small-cap companies may have more room to grow than larger companies. They may also be less risky, as they are not as well known and established as larger companies.
Further, small-cap companies have a lower market capitalization than the stocks of large, blue-chip companies. A stock is said to be a “blue chip” if it trades at high prices and represents sound investments; they are typically larger companies that are well established.
Why Invest in Small-Cap Funds?
Several reasons why you might want to invest in a small-cap fund are:
They offer potentially higher returns than large-cap funds.
Small-cap funds invest in smaller, rapidly growing companies. Small-cap companies may be undervalued by the market, which offers the potential for higher returns.
They offer the potential for greater capital appreciation than mid-cap funds.
A small-cap fund may invest in a company that is growing rapidly and has the potential to be a future giant. If the market undervalues this company, the share price could rise sharply, providing a capital appreciation for investors.
They offer exposure to the small-cap market.
A small-cap fund offers investors exposure to the small-cap market, which is made up of smaller, lesser-known companies. These companies may offer higher returns and capital appreciation potential than larger companies.
They are widely diversified.
A small-cap fund may invest in 10 to 30 companies. This can provide greater diversification than investing in a single company or two, which reduces the risk that an investor will lose money when one of the companies goes bankrupt.
Typically have lower expense ratios than other fund types.
Generally speaking, the larger the fund company, the more diversified they are. This means that their portfolio management fees are lower.
Offer fixed portfolio options for investors who want capital preservation with less volatility.
When investors want to invest in a fund that can give them fixed returns, it is best not to invest in the stock market. Small-cap funds may be riskier than other types of funds because they vary widely depending on how well each company performs.
The process of buying into a particular mutual fund can be daunting, but if you’re looking for a way to invest in smaller companies, a small-cap fund may be right for you.
Types of Small-Cap Value Funds
Mutual funds are the most common type of investment fund. They pool money from many investors and invest it collectively in securities, such as stocks or bonds.
Mutual funds can be actively managed, or they can follow a passive index-fund strategy. Index-based mutual funds seek to match the performance of an index by investing in stocks that closely represent that index.
Exchange-Traded Funds (ETFs)
Exchange-Traded Funds (ETFs) are a type of investment fund that trades on an exchange, just like stocks. They offer the diversification of a mutual fund with the flexibility of buying and selling shares throughout the day.
Like traditional mutual funds, ETFs own a collection of stocks or bonds that can actively manage or index.
An index fund is a collection of stocks or other securities that represents a portion of the market. Index funds seek to match the performance of their target index by investing in the securities that make up that index.
Advantages of Investing in a Small-Cap Fund
- Small-cap funds offer potentially higher returns than large-cap funds.
- They offer the potential for greater capital appreciation than mid-cap funds.
- They offer exposure to the small-cap market, which may provide opportunities for investors that are not available in other markets.
- They are widely diversified, which means that their performance is not tied to the success of any one particular company or sector.
- They typically have lower expense ratios than other fund types.
- Offer fixed portfolio options for investors who want capital preservation with less volatility.
Disadvantages of Investing in a Small-Cap Fund
- A small-cap fund may be riskier than a large-cap fund.
- Small-cap companies may have more room to grow than larger companies, but they are also less established and may be more volatile.
- A small-cap fund may not be as diversified as other types of funds.
- They typically have higher expense ratios than other fund types.
The Bottom Line
Small-cap funds may offer greater capital appreciation than other types of funds, but they are riskier. Prior to investing in a fund, you should carefully study the fund’s prospectus to understand how it invests, its fees and expenses, and whether it is appropriate for your investment goals.
When investing in a small-cap fund, it is essential to remember that these funds are risky and may be inappropriate for all investors. But, for those who are not afraid of the risk, small-cap funds can offer the potential for greater returns than other types of funds.
Disclaimer: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.